Question

Mackenzie Company has a price of $38 and will issue a dividend of $ 2.00 next year. It has a beta of 1.3, the risk-free rate is 5.2%, and the market risk premium is estimated to be 4.9%. a. Estimate the equity cost of capital for Mackenzie. b. Under the CGDM, at what rate do you need to expect Mackenzie's dividends to grow to get the same equity cost of capital as in part (a)?

Answer 1

Answer and Explanation:

a. The computation of the equity cost of capital is shown below:

As we know that

Expected rate of return = Risk free rate + Risk Premium × Beta

= 5.20% + 4.90% × 1.30

= 11.57%

b. Now the rate at which the dividend should be grow is

Value of the stock = Expected dividend ÷ (cost of equity - growth rate)

$38 = $2 ÷ (11.57% - growth rate)

so, the growth rate is 6.31%